Value Library

The following is an excerpt from the ABC Perspective - April 2010 - Pg. 4-5

ABC Fund Value Favourites

Canam Group Incorporated

Canam Group can trace its history back to 1960 with the founding of Canam Steel Works, a 12,000 square foot facility in Quebec. Over the years, the Company broadened its interests to include the manufacture of steel joists and decking, composite flooring, bridges and pre-engineered buildings.  With the appointment of Marc Dutil to the position of President and Chief Operating Officer in 2003 profit growth supplanted revenue growth as the key measure used to evaluate the success of the corporation.

The focus on the bottom line was readily apparent after examining Canam Group’s fiscal 2009 results.  The Company reported sales of $625.8 million, net earnings of $20.1 million and EPS of $0.45 during the worst year of the global recession.  Canam remained profitable largely due to bridge building and repair work and several large-scale structural steel projects.  Importantly, Canam’s rock-solid balance sheet gave the Company plenty of financial flexibility through the downturn.  At the end of 2009, the Company’s net debt was only $0.3 million, compared to $69.9 million at the end of 2008.  The Company’s net debt to equity ratio is now negligible, with shareholders’ equity of $400.6 million, or $8.83 per share.

We believe that the relatively robust financial results were overshadowed by the announcement on February 23rd, that Canam had increased its ownership in FabSouth from 15% to 80% for US$65 million.  Further, the Company has agreed to acquire the remaining 20% over a three year period starting in 2011, for an amount ranging between US$15 million and US$25 million depending on EBITDA generated in 2010, 2011 and 2012.

As we suspected, the initial purchase of 15% of FabSouth on December 23, 2009 was just the first step in acquiring control of the entire entity.  Remember that FabSouth is a leading structural steel fabricator that operates six plants located in Florida, North Carolina and Georgia.  The Company has approximately US$8 million to US$9 million in debt and about US$20 million of cash on its balance sheet.  The founders will continue to be involved in the business, which will be led by Kurt Langsenkamp, FabSouth’s president since inception.

In terms of financial performance, Canam has confirmed that between 2007 and 2009, FabSouth’s sales averaged more than US$325 million, bottoming at about US$250 million and peaking at about US$400 million.  Marcel Dutil implied that he sold his 15% stake to Canam at marginally above two times EBITDA, while the 65% interest was purchased at a slightly higher multiple but below three times EBITDA.  Basically, Canam Group will be paying approximately US$90 million to US$100 million for $50 million of incremental EBITDA. This is extraordinarily cheap.

Although the market reaction seemed delayed, investors have begun to grasp the significance of this transaction.  Marc Dutil has astutely deployed some of the firepower on Canam’s pristine balance sheet to make a significant and accretive acquisition in the United States using the strong Canadian dollar, at a very attractive price.  In the days following the news release, the shares of Canam Group broke above the upper boundary of the stock’s year and a half-old trading range.

Essentially, the FabSouth acquisition was the catalyst to finally drive the stock price above the Company’s book value of $8.83 per share.  We believe that the market has recognized that Canam’s peak earnings power will be substantially higher in the coming cycle than in past cycles.

Daylight Resources Trust

Daylight Resources Trust is a mid-cap conventional royalty trust that is anticipated to produce over 45,000 boe/d of natural gas and oil in 2010.  The recent acquisitions of Highpine Oil and Gas Limited and West Energy Limited created a more balanced production mix by increasing the oil and liquids weighting from 28% to 45%.  Daylight currently pays a distribution of $0.08 per month, or $0.96 per year, which yields approximately 9.25% today.

Despite the weak natural gas price, Daylight’s acquisition of Highpine Oil and Gas Limited gave us the confidence to build a meaningful position in the Trust.  At the time, the $530 million acquisition was accretive to cash flow, rebalanced the production mix from 28% to 42% oil and liquids, improved the debt to cash flow ratio to 0.9 times and created a much more substantial entity with an enterprise value of approximately $1.8 billion.

The Trust subsequently announced an arrangement agreement to acquire all of the outstanding shares of West Energy Limited.  This transaction is consistent with our investment thesis that Daylight’s management is building a much larger entity through a combination of organic growth and accretive acquisitions.  Importantly, the purchase consolidates the Trust’s existing position in the Pembina region of Central Alberta, adding over 100,000 net acres of undeveloped land and 40 net sections of Cardium oil rights.

This acquisition is valued at approximately $570 million, including the assumption of $135 million of net debt.  Consideration is comprised of $115 million of cash, with the balance to be paid in Daylight units.  On a per share basis, each West stakeholder will receive either $5.50 in cash, 0.465 of a Daylight unit, or some combination thereof such that the total cash component does not exceed $115 million.  Currently, West Energy is trading at approximately $5.00 per share, an 18% premium to the average trading price over the ten days prior to the offer being made public.  Based on West’s recently released year-end documents, Daylight purchased the Company below its net asset value of $5.96 per share.

Assuming estimated land value of approximately $110 million, Daylight is paying $79,300 per flowing barrel and $23.84 per barrel of proven and probable reserves.  Although at first glance these multiples are not cheap, the price is relatively easy to justify.  West’s light oil production of 5,800 barrels per day generates operating netbacks of $38.26 per barrel at US$80 WTI oil and $5.25/mcf AECO natural gas.  It is this high netback per barrel relative to the price paid per barrel of proven and probable reserves that should allow the Trust to generate a solid economic return on its investment over time.  Additionally, the overlap of the land positions should allow a reduction in operating costs by sharing oil facilities and systems.  Finally, the complementary land base creates a large inventory of repeatable drilling opportunities.  Management now estimates an unrisked horizontal drilling inventory of 300 to 600 Cardium oil locations at Pembina.

We expect the transaction to close mid-to-late May, sometime after Daylight’s conversion to a corporation.  Investors should then expect to receive a $0.05 dividend per month compared to the current $0.08. The combined entity will have over $1.7 billion of tax pools, which should be available to defer taxation in future years.  Eventually, Daylight could become one of the premier, mid-tier E&P companies in North America as they continue to grow production, reserves, cash flow and net asset value.

Irwin A. Michael, CFA